Goldman Sachs Gets Bullish on Basic Materials

From Brad Hoppmann: When a top investment bank reverses course and makes a bullish call on a sector, it’s a good idea to pay close attention.

This week, Goldman Sachs (GS) upgraded its outlook on commodities and basic materials. Analysts say the segment is poised for a strong run next year — with prices for oil, coal, iron ore, nickel and zinc all likely to rise.

The upgrade on the basic materials sector to “Overweight” was the first time GS has made such a move in four years.

“We believe the recent reacceleration in global PMIs (purchasing managers’ indexes) suggests commodity markets are entering a cyclically stronger environment … Supply restrictions from policy actions should benefit oil, coking coal and nickel in the near term while economic reductions should boost natural gas and zinc.”

So, what does an upgrade to “Overweight” mean in terms of actual expected percentage upside?

Goldman analysts think that commodities as a sector, as tracked by the Goldman Sachs Commodity Index, could jump 9% over the next three months. That forecast represents a huge turnaround from the previous forecast for a decline of 2%.

The question now is … why the change of heart?

Big spending on big infrastructure will cause a big boost in demand for basic materials.And prices are adjusting to that potential outcome accordingly.The most-obvious answer here is that commodity prices — particularly industrial commodities and basic materials — are charging higher. This is happening in anticipation of a Trump administration and a compliant Republican Congress ready to act on the promise of a $1 trillion infrastructure spending spree.

Yet here, Goldman cautions investors not to jump to this conclusion.

Per the TheStreet.com article:

“It is tempting to blame the sharp post-election rally in industrial metals prices on President-elect Trump’s platform of lower taxation and higher public spending on infrastructure … We would argue this rally was a continuation of a reflation trend put in place at the start of 2016 by the Chinese through credit stimulus aimed at infrastructure projects and policy-driven supply curtailments in coal.”

The overall reflation trend certainly has had a hand in pushing coal and iron ore prices higher this year. But I think Goldman is understating the “Trump effect” when it comes to the latest boost in the segment.

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All we need do is look at a recent price chart of the benchmark basic materials fund, the iShares U.S. Basic Materials ETF (NYSE:IYM), to see the reversal of fortune that took place on Nov. 9.

As you can see, the price of basic materials had been trending lower in the two months preceding Election Day.

Then, not coincidentally, the sector soared on Nov. 9. That’s when traders began pricing in the pro-growth policies, as well as the infrastructure buildout, that’s at the heart of the president-elect’s economic proposals.

Now, while it may be tempting to jump into a sector like basic materials on the promise of a Trump “reflation trade,” I think it is a bit premature right now.

There are still numerous unknowns regarding what a Trump administration will do, and what kind of infrastructure buildout will occur … and at what pace.

Still, it is safe to say that the Goldman call is a step in the right direction. It recognizes a reversal of fortune for the industrial commodities and basic materials sector … a reversal that, if sustainable, will be a leading indicator signaling future economic growth.